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Transformation financing and transforming enterprises

The transition of micro and small enterprises to bigger entities, playing in the formal sector is good for the economy. It is actually one of the dreams of those concerned with the development of that sector. However, in the euphoria of this growth and transition, we often overlook the challenges that confront transiting enterprises, and their financiers with regard to the level of funding a transiting entity should be provided with. The challenges of growth and transition and, indeed, the requirements of sustained production, are often important issues to manage as enterprises grow. One of the many ways of assessing the effectiveness of microfinance is to see how enterprises or client’s transit from one level to the other, often judged by the size of loans they are granted.

The operators involved in real microfinancing are close to their clients and they monitor their progress. This often results in the operator wanting to increase funding to the client after meeting certain standards. However, the client may not be ready to take on more funds. It may be that the client does not see the opportunities that are evident to the financing institution. An there are many reasons why the client will not easily see such opportunities. In reality, this scenario actually plays out in different ways as MSMEs grow. This is common with the very low-level groups of clients in microfinancing. This situation to me, is exactly one of the reasons the microfinance intuition is there.

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Inability of financiers and their clients to agree that the latter should move on to a higher level of funding sometimes creates difficulties about measurement of the impact of financing on the clients or enterprises. And we must distinguish this issue from the problem of loan-fatigue or being over borrowed. Every operator should be conversant with the consequences of putting more loans on the client, beyond their needs. Ability to help the client to see the opportunities inherent in growth and transition is an important attribute of the operator and makes a lot of difference in outcomes.

All over the world, small businesses are supported by credit programmes that are tailored to their needs. These programmes provide them with friendly credit facilities – loans and advances, capacity building support and asset protection insurance services, among others. Many international organizations, including some non-profit institutions based in Europe and the United States, and even Latin America, have advanced the development of the small enterprise sector through a variety of such supportive financing models.

It is important to note that as micro, small and medium enterprises develop and expand, their needs also change and expand. New and bigger challenges show up in their faces. Often, the first thing that happens is that the composition of their personnel will change from a largely family labour force to a mix of family and hired labour, and responsibilities begin to get defined. This implies the introduction of substantial internal reforms in such areas as record-keeping and general administration with enhanced division of labour. At this point, it is good for the leader to begin to give up some of the many things that eat up his valuable time. He needs to begin to accept that the leader cannot do everything alone.

One critical functional change at this stage in the case of SMEs is in the area of cash management. It should no longer be the case at this point that the leader sees the business as himself and its funds as his funds. A distinction between the two has become very important. The key evidence that this is happening is a change in the cash management process. The enlarged operating expenses, raw materials and staff costs, higher investment expenditure and so on that arise imply that time has come for business and family finance to be distinguished.

The next important change often occurs in the markets and marketing of the products of the enterprise. The local or neighbourhood markets may no longer be adequate as production increases. Effort must be made to expand the market and customer base beyond the immediate environment. Growing enterprises must therefore seek and find new markets and customer bases to absorb their expanding output, if their success is not to be short-lived.

The expansion into new markets raises yet another challenge – the challenge of technology. The larger output that targets the new markets is not likely to be produced under the existing technological capacity of the firm. The key man must at this time agree that the time has also come for upgrading of the machines, systems and entire technology, to meet the needs of the growing customer base. At this time, the need to ensure that supply lines are secure equally becomes critical. With expanding markets and effective technology to deliver the output, the enterprise must not allow its own suppliers to become the stumbling block on its way.

Finally, among the key challenges of growth is credit. Micro and small enterprises usually begin as integrated firms. They produce their own inputs in the form of raw materials. They buy unprocessed goods in bulk and resale. While the reliance on outside suppliers and larger output calls for increased capitalisation, especially of the working capital category, the need for increased technology and equipment calls for increased fixed asset investment capital.

There are various methodologies for addressing MSME finance. Each of them has in its DNA something that links it to particular types of small enterprises in need of growth and development. Ideally, as enterprises pass through various stages of development, they are supposed to be embraced and served by different institutional finance types that are properly attuned to their needs. Unfortunately, this is not always the case and operators make do with what they find.

The Village Banking methodology of microenterprise finance focuses on the poorest clients, especially those run by women and engaged in the simplest enterprise activities. This methodology of enterprise finance was pioneered by the Foundation for International Community Assistance (FINCA), a United States-based non-profit organisation that specializes in rural credit, FINCA has been operating in several Latin American countries where it has been promoting the technology of village banking, including Mexico, Thailand, Costa Rica and even Guatemala.

Peer group lending has been extensively promoted in the search for ways to eliminate the challenge of collaterals in microenterprise financing. The Solidarity Group lending methodology, which has been fairly successful in this regard also has its own best category of clients, for whom it is best suited. This form of financing targets the slightly more established entities, with fairly precise identity. The requirement of bonding in groups presupposes some level of organizational foundations. Transformation lending is concerned with entrepreneurs that have grown beyond the rudiments and have expanded their operations substantially beyond their present level and require to transit to the next. Special skills horned on deep understanding of client’s attributes is central.


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